Friday Preview: Stocks on Track for Worst May Since 1962

Stocks wind down what's shaping up to be the worst May since 1962 but could end the week on an upswing, if there's no fresh bad news from Europe.

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The Dow jumped 284 points, or 2.9 percent Thursday to 10,258, and the S&P 500 rose 35 points, or 3.3 percent to 1103. Stocks turned higher Thursday as China denied that it was reviewing its euro zone bond holdings, a story that drove stocks lower into Wednesday's close.

The market is set up for its worst monthly decline since February, 2009 when the key indices lost about 11 percent. The Dow is currently down 6.8 percent for the month, its worst May decline since the 7.8 percent it lost in 1962, and the S&P 500 is down 7 percent for the month, its worst May since the 8.6 percent loss in 1962.

Energy stocks were among the best performers, up more than 4 percent, as the price of crude rose but also as British Petroleum appeared to have some success stopping the spewing oil on the Gulf of Mexico floor. President Obama announced a moratorium on new deep water offshore drilling which helps support crude prices as does a warning from the government Thursday that the hurricane season could be the worst since 2005. Oil rose $3.04 or 4.3 percent to $74.55 per barrel.

The euro gained 1.4 percent against the dollar, to finish at $1.2362. Bonds were the big losers of the day, with yields rising sharply as investors sold. The 10-year yield climbed to 3.34 percent, its highest level since May 19, and the 2-year yield climbed to 0.877 percent, its highest yield since May 5.

"Typically on a day like this, you fade it because tomorrow you'll walk in and everyone's hair is going to be on fire again," said Steve Massocca of Wedbush Securities. But Massocca said it may be that the market instead trades higher in what should be relatively quiet pre-holiday trading Friday.

The stock market is open for a full day Friday, but the bond market closes at 2 p.m. and interest rate and foreign exchange futures close at 1 p.m.

Rick Klingman, managing director, Treasury trading at BNP Paribas, said there seemed to be a concerted move away from bonds Thursday, and the $30 billion auction of 7-year notes was just mediocre. "It seems today there's a pretty good rotation out of bonds into equities. The back end of our market has been weak," he said.

There are a few data points for markets to consider Friday. Personal income and spending are released at 8:30 a.m. Chicago purchasing managers data is at 9:45 a.m., and consumer sentiment is released at 9:55 a.m.

Massocca said the market's direction depends on Europe right now. "All eyes are on Europe. The fact the euro did well today, European markets did well today. That's really the news...I think this rally continues again tomorrow. I put some shorts on but nothing serious," he said.

"We're narrowly above the the levels of the last four days, which I think will hearten a few people," Massocca said, adding "I don't think we're out of the woods yet."

'We're Not Out of the Woods Yet'

That was also the headline of a note written by Harris Private Bank CIO Jack Ablin Thursday. Ablin relies on a combination of five metrics to gauge the stock market and one of them is a momentum indicator. If the S&P slips five percent below its 200-day moving average, he would raise cash because the market would experience a "momentum breakdown."

He said he's been warning investors to beware. The "breakdown" level is 1048. The market moved below that level and opened below it, but has not closed below it. The last time the market "broke down" by this metric was January, 2008. On the other hand, momentum flashes a buy signal, if the market closes 5 percent above the 200-day moving average.

Ablin said if it does break through on a closing basis, "we'd certainly do an across-the-board risk reduction."

"I think the overarching belief that sort of keys off this strategy is that we're in a secular sideways market. This is not a market that you can buy and hold right now. We don't think we're there. We're going to need some major public pieces changed before you could declare victory," he said. Some of those issues include the fiscal struggles of state and local governments and the U.S. federal budget deficit.

"If you take that strategy and go back 10 years, what we did was invest $1000 in the S&P 500. On a buy and hold basis, that would be worth $780. if you invested in the market strategy, it's worth nearly $1,800 dollars. That's why I'm going to stay with it, because it's so powerful," he said..

VIX

The VIX, the CBOE's volatility index, lost 15 percent to 29.68 Thursday, its first close below 30 in two weeks. The VIX is known as the market's fear index and has been running up recently.

"I think the VIX is more an indicator telling you what the market's done rather than what it's going to do, and typically when you have big spikes in the VIX, it's coming to the time the market's done going down," said Paul Hickey, co-founder of Bespoke Investments. Hickey said the VIX tends to drift down more slowly when it spikes higher.

Hickey said the VIX chart reflected a "golden cross" formation. "Today the short-term moving average went above the long-term moving average. That shows you there's a shift in the trend of it. I wouldn't read too much into it as far as major implications on the market. There's a lot of people following the VIX, and it's an interesting noteworthy point," he said.

Hickey said Bespoke looked back at other occurrences and found that two-thirds of the time the stock market was positive three months after such a move in the VIX and it was mostly positive in the first month.

He said, however, the outlier data was during the worst of the chaos of the financial crisis. "One of the things we're seeing is with a lot of indicators we look at, the overwhelming majority of the time, the market was positive three months later...The last time is a real doozy and real outlier so what you have is investors suffering from "most recently bias."

Bespoke also took a look at a batch of battered stocks in the Russell 1000. They found stocks down 20 percent or more from the April 23rd peak and picked some that looked ready to bounce.

The list includes Popular Inc, Dover Corp, Ford, Hertz, Interpublic, Liberty Media, Marshall and Ilsley, Royal Caribbean, Trinity Industries, USG and Zions Bank. All of those stocks were higher Thursday.